Justin Fox's "The Myth of the Rational Investor" has an interesting story about the origin of the CRSP that makes me wonder about the neutrality of that 1926 starting point. It appears that the CRSP might have been conceived in sin, as it were. It was launched specifically because in 1959 Louis Engel of Merrill Lynch wanted to run an ad, and the SEC said he couldn't because he didn't have the evidence to back up his claims. The CRSP was founded specifically to provide that evidence. The study was funded, and the ad using CRSP data duly ran on July 2nd, 1964 in the Wall Street Journal.

The question that arises in my mind is: how exactly was 1926 chosen? It is said that it was chosen so as to include at least one full business cycle, but I have to wonder about the possibility of some unconscious cherry-picking in there in order to give Merrill Lynch the results they wanted. Even over a period of 40 years, it would have made quite a difference whether the starting point was the start of 1926 or, say, 1929.

Chicago Booth magazine says "In 1959, associate dean James Lorie fielded an intriguing call from Louis Engel, a vice president at Merrill Lynch, Pierce, Fenner & Smith. The firm wanted to advertise how well people had done investing in common stocks, but Engel needed solid data and wanted Booth faculty to help collect it," omitting only the detail about the SEC. The CRSP itself has an article about Engel from which I got this page image (alas, not high enough resolution to read much more than the title).

nisiprius wrote:Justin Fox's "The Myth of the Rational Investor" has an interesting story about the origin of the CRSP that makes me wonder about the neutrality of that 1926 starting point. It appears that the CRSP might have been conceived in sin, as it were. It was launched specifically because in 1959 Louis Engel of Merrill Lynch wanted to run an ad, and the SEC said he couldn't because he didn't have the evidence to back up his claims. The CRSP was founded specifically to provide that evidence. The study was funded, and the ad using CRSP data duly ran on July 2nd, 1964 in the Wall Street Journal.

The question that arises in my mind is: how exactly was 1926 chosen? It is said that it was chosen so as to include at least one full business cycle, but I have to wonder about the possibility of some unconscious cherry-picking in there in order to give Merrill Lynch the results they wanted. Even over a period of 40 years, it would have made quite a difference whether the starting point was the start of 1926 or, say, 1929.

Chicago Booth magazine says "In 1959, associate dean James Lorie fielded an intriguing call from Louis Engel, a vice president at Merrill Lynch, Pierce, Fenner & Smith. The firm wanted to advertise how well people had done investing in common stocks, but Engel needed solid data and wanted Booth faculty to help collect it," omitting only the detail about the SEC. The CRSP itself has an article about Engel from which I got this page image (alas, not high enough resolution to read much more than the title).

It ignores 1901-1920 which were horrible for stocks, the longest secular bear market of the century. To whatever extent I have considered the past as prologue, I have always taken into account the first fifth of the century. I mean, really, how could you do it otherwise and claim objectivity?

I certainly don't think the choice of 1926 was blatant cheating. And as will be seen the first presentation of the data gave results for 22 selected pairs of endpoints. The "selected endpoints" is a bit weird, but to me the actual choices do have the flavor of "good-faith effort," not "cherry-picking."

But I still think there are questions to be asked. Despite the integrity of researchers and the peer review process, there is such a thing as funding bias. The CRSP's own description of their history talks about Engel telephoning Lorie, but omits the salient details that Engel wanted (and ultimately used) the information for an ad--and that the SEC had played a role in the story.

"Rates of Return on Investments in Common Stocks" L. Fisher and J. H. Lorie, The Journal of Business, Vol. 37, No. 1 (Jan., 1964), pp. 1-21, says that "This work is the first to emerge from the Center for Research in Security Prices (sponsored by Merrill Lynch, Pierce, Fenner & Smith Inc.)" and opens with a description of CRSP that states

The sole purpose of the Centerfor Research in Security Prices is to conduct research and to disseminate the results throughout the academic and financial communities.This is what Merrill Lynch, Pierce, Fenner & Smith Inc. had in mind when they provided the funds to establish the Center, and this is what the Graduate School of Business had in mind when it sought support.

Methinks the lady doth protest too much; the prompt dissemination of those results to retail investors via the medium of a Merrill Lynch ad is not quite consistent with the CRSP's "sole purpose." I haven't found a high-res image of the newspaper ad, but if you squint at table 1 from the paper below, and the ad above, it sure looks as if the 1965 Merrill Lynch ad reproduced this and two other tables from the paper. That is, there was a direct connection between paper and ad.

Now, as to 1926, The paper says "Monthly closing prices from the New York Stock Exchange from January, 1926 through December, 1960 have been placed on tape." That's really all there is. As nearly as I can tell, the paper does not give any explanation at all of the starting date.

The paper--yes, a genuine research breakthrough--presented data from equally-weighted investments because "a policy of allocating funds in proportion to shares outstanding or according to any other criterion implies less neutrality of judgement in making investments." A footnote says that they tried cap-weighting and some results were higher, some lower, and there was no systematic difference and the yields were "generally similar." OK.

To their great credit, they

included reinvested dividends

included expenses (showing results with and without expenses)

included taxes, three different brackets.

Inflation and real returns were not discussed, which seems like an oversight given that the postwar inflation, one of the highest in U.S. history, ought to have been a recent memory.

The results were presented according to a set of chosen pairs of endpoints.

As to the endpoints, their explanation is "The periods were chosen for obvious reasons." (!) In full:

The periods were chosen for obvious reasons. The period from 1926 to 1960 is a long span with booms and depressions--prime examples of each!--and war and peace. The periods beginning in September, 1929 were included to indicate the experience of those who invested at the height of the stock-market boom of the 1920s. The periods beginning in June, 1932 were included to show the results of investing at the nadir of this country's worst depression. The numerous brief, recent periods were included to bring details of postwar experience into sharp focus. Aside from most periods ending in 1932 or 1940, the rates of return are surprisingly high...

One of the challenges for us today due to this choice and the popularity of this data set is understand "long term" market behavior. In particular things like the use of rolling 30-year retirement periods when looking at SWR (etc.).

If you start in 1926, there are only 4 periods that include the crash of 1929. But there are 14 periods that include the roaring year of 1999, other years in the middle get counted 30 times, and only a few that include the latest crash.

So this shows a glaring weakness in using rolling periods, but also shows a perhaps accidental problem of end point bias due to starting in 1926, and well as end point bias on the other end of the data (this is of course unavoidable as we can't know the future).

We live a world with knowledge of the future markets has less than one significant figure. And people will still and always demand answers to three significant digits.

If I look at the recent Credit Suisse 2013 Investor Yearbook, it tells me that the real return on US stocks from 1900-2012 was +6.3%. From 1926-2012, the CRSP 1-10 Index earned a +6.7% real return. Ironically, I use 1928 as a starting date for illustrating long-term US asset class returns, and over this period ('28'-'12), the CRSP real return was also +6.3%. It was about +8.7% for an equity allocation split between large/small and growth/value.

No, it appears like the real hazard for using the 1926 starting date is on real bond returns. The CS publication tells us US bonds earned a +2.0% real return from 1900-2012, while the LT Gov't Bond Index they use earned 35% more than this, or +2.7% real from 1926-2012. How can that be? Well, 1900-1926 conveniently ignores what appears to be an almost 3 decade period of negative real returns on bonds (but not bills).

As to the time dependency and issue with the return history we have, I think that investors get a false sense of security on fixed income, not stocks. It appears as though, in the last 110+ years, we've had two bursts of outstanding bond returns followed by multiple decades of negative real returns. Eyeballing CS:

1900-1922 = negative real bond returns (broke even in 1930)1923-1940 = real bond returns of 6-8% per year1940-1982 = negative real bond returns of over 1.5% per year (cumulative negative real returns since 1900)1983-2012 = real bond returns of about 7% per year

While investors seem to be up in arms about the prospect for negative real returns on bonds today going forward, it appears like this is more the historical norm than the exception.

The result that impresses me is the returns from just prior to the crash 9/29. 7.7 percent as compared to 1926 which had a 1.3 percentage point higher return (I do not view this as an overly large difference - but one over 40 years, so ....) - yes we all would like the higher return - but I suspect most of us make predictions on our equity position that will be +/- several percentage points from reality. (Hopefully + )

Yes, they could have picked 1920 - but I suspect people would have seen through this only a few decades out.

By picking 1926 - they had a three year stretch when stocks doubled (including back to back years of over 35% returns per Shiller).

I saw that the Dow was up 25% through Sept 1929 (more if annualized)... not sure about other indexes ... but the paper's data shows 1926 to 9/29 a per year return of 20% ... which is much less than what Shiller ... quite a difference ...anyone have an understanding of why the difference? Perhaps different indexing methodology?

As I recall, we don't look back in the 1800's (which did have a bunch of rolling depressions) because "industry" during that time on the equity side was heavy in railroads and I think, banks to a point.

One thought is that mass production really started to ramp up once manufacturing operations started utilizing electricity which was far more efficient than steam energy. To me, that's the "modern" era. I believe it started in the 1880's-1890's and once the AC motor replaced the DC motor as the motor of choice, mass production really ramped up. Development of the electrical grid was also important for mass production.

If you look at housing, pricing (Shiller adjusted) dropped in the early 1910's as mass-production started in earnest with that particular industry.

The car industry (Ford) also started to mass produce in the early 1910's.

Why 1926? Because some guy deemed it so. Perhaps that data was easier to gather moving forward from 1926 or perhaps they said "that's enough".

RM

I figure the odds be fifty-fifty I just might have something to say. FZ